International Capital Flows, Exchange Rates and Domestic Monetary Policy

Abstract

Under the Bretton Woods system exchange rates were essentially fixed and were adjusted only periodically to correct fundamental balance of payments disequilibrium. Central banks were required to buy or sell domestic currency on the exchange market at the pre-determined rate. Net capital flows were thought mainly to depend on interest rate differentials and, in the relatively stable decades of the 1950s and 1960s, were not accorded much importance in the analysis of economists or in the priorities of policy-makers. This situation changed during the 1970s, however, after a period of large US payments deficits and the withdrawal of the convertibility of the dollar into gold. The international monetary system came under hitherto unknown pressures and the final attempts to maintain fixed parities failed largely because national authorities found that it had become increasingly difficult to reconcile external and internal objectives.

The present paper reflects the opinions of the authors and does not purport to represent those of the institution (OECD) to which they belong. It has benefited from comments by Val Koromzay. The authors are responsible for any remaining errors and omissions.